ARTICLES

REGULATION OF SECURITIES INDUSTRYINTERMEDIARIES - AUSTRALIAN PROPOSALS

PAUL LATIMER*

1. INTRODUCTION

In its one hundred ninety-eight page A Review of the LicensingProvisions of the Securities Industry Act and Codes (Review) pub-lished in October 1985,1 the Australian National Companies and Se-curities Commission, upon reviewing the licensing provisions of the Se-curities Industry Act of 1980 Commonwealth and Codes, stated whatmany had long felt, that "the present licensing system is not workingadequately to provide adequate investor protection."'2 The Review con-siders, instead, a move to the United States/Canadian model of super-vised self-regulation by self-regulatory organizations (SROs) in combi-nation with the maintenance of the existing method of regulation by theCommission.3

This article endeavors to address the Australian proposals and tocompare them with the North American experience. In particular, thearticle will initially review the various theories of occupational licen-sure.4 Next, it will discuss the ramifications of self-regulation by

* PAUL LATIMER is senior lecturer in law in the Department of Accounting andFinance at Monash University, Melbourne, Australia. He has worked in the privateand public sector, researched, written and taught in the areas of commercial law andtax since 1974 and is a graduate of the University of New South Wales (B.A., Dip.Ed.,1969) and of the University of Sydney Law School (LL.B., 1975, LL.M., 1978). Hehas published numerous articles and notes in Australian university and professionallaw reviews, has authored or co-authored five books, and is the author of the majorwork of some 1200 pages, Australian Business Law (COH Australia Ltd.), publishedannually since 1981.

' NATIONAL COMPANIES AND SECURITIES COMMISSION, A REVIEW OF THE LI-CENSING PROVISIONS OF THE SECURITIES INDUSTRY ACT AND CODES (1985) (A dis-cussion document with proposals for the reform of Part IV and other provisions, andregulations of the Securities Industry Act and Codes relating to licensing of securitiesindustry participants) [hereinafter REVIEW].

, Id. para. 2.1.* Id. paras. 10.1 -.66.' See infra notes 37-56 and accompanying text.

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SROs.5 The article will conclude with an examination of several eco-nomic theories of regulation and their implications for the proposals inthe Review.6

2. BACKGROUND

2.1. Australian Company Law

There is no nationwide control by the Australian Canberra-basedFederal Parliament of company and securities law in Australia's sixstates and two territories. Uncertainties created by the High Court ofAustralia's interpretation of the scope of the "corporation's power"under the Australian Federal Constitution has resulted in the evolutionof a cooperative scheme of state- and territory-based regulation.8 Thesystem is comprised of the six states and the two territories (the Austra-lian Capital Territory and the Northern Territory, which joined thescheme on July 1, 1986). By the "Formal Agreement" of December 22,1978,' the six states and the federal government (which also adminis-ters the Australian Capital Territory) bound themselves into a decision-making structure for the establishment and implementation of the coop-erative scheme, based upon coordinated regulation of the existing stateand territory infrastructures. Such regulation would be undertaken bytwo bodies, the Ministerial Council for Companies and Securities, andthe National Companies and Securities Commission. 0

The Ministerial Council, the political master of the cooperativescheme, includes the Attorney General of each of the six states and the

s See infra notes 57-109 and accompanying text.

o See infra notes 110-18 and accompanying text.

"The Parliament shall, subject to this Constitution, have power to make laws forthe peace, order and good government of the Commonwealth with respect to . . .For-eign corporations, and trading or financial corporations formed within the limits of theCommonwealth." AUSTL. CONST. § 51.

' See, e.g., Companies Act, 1981, AUSTL. AcTs P. No. 89, § 3(1) (act intended toprovide for the formation, regulation, and registration of companies within the Austra-lian Capital Territory); Companies and Securities (Interpretation and MiscellaneousProvisions) Act, 1980, AUSTL. AcTs P. No. 68, § 3(1) (act intended to regulate thesecurities industry in the Australian Capital Territory); Companies (Acquisition ofShares) Act, 1980, AUSTL. AcTs P. No. 65, § 3 (act intended to regulate acquisition ofshares of companies incorporated in the Australian Capital Territory); National Com-panies and Securities Commission Act, 1979, AUSTL. AcTs P. No. 173, § 6(3) (actcreating commission with power to recommend adoption of new laws or changes inexisting laws relating to the securities industry within the Australian CapitalTerritory).

I REVIEW, supra note 1, at viii-ix (Preface). The "Formal Agreement" is aSchedule to the National Companies and Securities Commission Act, 1979, AUSTL.ACTS P. No. 173 (statute outlining basic powers of Ministerial Council created pursu-ant to Formal Agreement of December 22, 1978).

10 REVIEW, supra note 1, at viii-ix (Preface).

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federal government. It has the overall responsibility for the operationand administration of the regulatory plan."1

The National Companies and Securities Commission (Commis-sion), the Australian equivalent of the Securities and Exchange Com-mission (SEC), is largely responsible for policy development throughsecurities legislation and for the administration of the companies andsecurities legislation. Based in Melbourne, it encompasses only a staffof about eighty, a large number of whom are professionally qualified inareas such as accounting, economics, and law. The legislation conferson the Commission wide discretion and power over takeovers, companyadministration, and legislative and administrative development. In es-sence, the Australian legislation requires the licensing of all market ac-tors, subject to the exemptions set out hereunder, so that their activitiescan be supervised by the Commission and its delegates. Under the Se-curities Industry Act of 1980 and Codes,12 licenses are divided into fourcategories: 1)Dealer's license;" 2)Dealer's representative; 4 3)Invest-ment adviser;1 5 and 4)Investment representative.1" Application formsand procedures are set out in the Securities Industry Act and Codesand Regulations and include specific grounds upon which registrationmay be denied, 1 subject to the right to a hearing. 8 In addition, theCommission can establish minimum fraud requirements for dealers."This standard mirrors the U. S. provisions in the Securities ExchangeAct of 1934.20

At present the Australian securities legislation exempts several se-curities market actors or products from regulation: life insurance com-pany bonds, monies going to indirect personal investment (such as port-folio management, equity trustees, life insurance), new insuranceproducts (such as cash management trusts), and the investment advisoryindustry.2' Technical advances and the erosion of investment productsegmentation have led to diversification, as has internationalization ofthe securities market through dealing in Australian shares on the

"I Id. See generally National Companies and Securities Commission Act, 1979,AUSTL. AcTs P. No. 173 (statute created pursuant to Formal Agreement of December22, 1978).

11 Securities Industry Act, 1980, AUSTL. AcTs P. No. 66.1- Id. § 43.14 Id. § 44.

15 Id. § 45.1o Id. § 46.17 Securities Industry Act, 1980, AUSTL. AcTs P. No. 66, § 48.1s Id. § 62.19 Id. § 51(3).20 15 U.S.C. § 78o(c)(3) (1982).1 Securities Industry Act, 1980, AUSTL. AcTs P. No. 66, § 4.

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London Stock Exchange and quoting Australian stock on NASDAQand the U.S. over-the-counter market.

Moreover, under the Securities Industry Act and Codes, externalsurveillance occurs in various forms. The Commission has the power torequire information to be furnished, 2 to receive accounts and annualstatements, 2s and to revoke and suspend licenses.2" The Commissioncan also apply to the court for various orders in the event of a violationof the legislation, 25 including an order for the observance or enforce-ment of either the business rules or listing rules of the stock exchange.28

The preexisting Corporate Affairs Commissions of each of the sixstates and the two territories continue under the cooperative scheme asdecentralized delegates of the National Companies and SecuritiesCommission.

2.2. Licensing of Securities Industry Participants

The licensing of those dealing in securities, as well as those mer-chandizing related information, is the basic mechanism of control usedin common law jurisdictions such as the United States, 27 Canada, 8 theUnited Kingdom (U.K.),29 and Australia." °

22 Id. § 53.23 Id. § 56; Part IV.24 Id. § 59.25 Id. § 14.20 Id. § 42.27 In the United States, licensing requirements for those dealing in securities is

provided by the Securities Exchange Act of 1934, 15 U.S.C. § 78(a) (1982). Section15(a)(1) requires the registration of any securities broker or dealer falling within theconstitutional scope of the Act. Id. § 78o(a)(1). Section 15(b) details specific groundsupon which such registration may be denied. Id. § 78o(b)(1). Similarly, Section 203(c)(2), (e) of the Investment Advisers Act provides for denial of registration as an ad-viser. Id. § 80b-3(c)(2), 3(c). Section 15(c)(3) of the Securities Exchange Act of 1934directs that the Commission establish minimum financial requirements for brokers anddealers. Id. § 78o(c)(3). Exempted are banks, id. § 78c(a)(4)-(15), persons who do notqualify as a "broker" or a "dealer", id. § 78o(c)(3), and investment advisers, id. §78c(a)(20), 80b-2(a)(11), though the latter require registration under The InvestmentAdvisers Act.

External surveillance takes various forms, including authorizing the SEC to setlicensing standards, id. § 78o(b)(2), and to prescribe tests of competency. Id. Addition-ally, willful violation of SEC rules is a felony under Section 78ff(a). L. Loss, FUNDA-MENTALS OF SECURITIES REGULATION 693 (1983).

28 In Canada, Manitoba was the first province to impose a licensing requirementfor the sale of securities. Sale of Shares Act, 1912, 2 Geo. 5, ch. 75 (Man.).

1, In the United Kingdom, there is the Prevention of Fraud (Investments) Act,1958, 6 & 7 Eliz. 2, ch. 45, § 1.

1* In Australia, the origins of the regulation of dealers and investment advisersand their representatives goes back to the Securities Industry Act, 1970/71 (N.S.W.,Victoria, Queensland and Western Australia), drafted in response to securities industryabuses that occurred during the 1960's and were later documented in SENATE SELECT

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The goals of licensing include the need to ensure the adequacy ofdealer capitalization, to exclude the untrained and unqualified from theindustry, to provide for and strengthen those rules in the public inter-est, and to enforce compliance with ethical standards."' Underlyingthese goals is the recognition that the quality of the service providedcannot be judged by the consumer at the time of consumption, thuspotentially providing serious financial harm to the unknowingcustomer.

The view is widely held, and is recognized in the Review, 2 thatAustralia's current system of dealer-investment adviser licensing doesnot achieve these goals. Initially, the volume of licenses issued, increas-ing from some 4,000 in 1981 to some 14,000 in 1985, appears to bebeyond the regulatory capability of the current personnel."3 Moreover,licensing is sometimes recognized as achieving only one purpose, that ofraising revenue for the regulator.3 4

The conflict at the core of any licensing scheme is how to maintainequilibrium, that is, how to make the distinction between financial sta-bility, knowledge, and so forth, while recognizing licensing as an inter-ference with freedom, a barrier to entry of an occupation, and an an-ticompetitive creation of exclusivity by legislative decree.3 5 Anylicensing system must recognize that all have a right to earn a living,and that the grounds on which registration is to be denied should bespecific, clearly defined in advance, and void of generalized and oftenunchallengeable "public interest" requirements.

The Australian proposals are based on the premise that the pre-sent system of licensing dealers, investment advisers, and their repre-sentatives provides inadequate protection to investors. In particular, theproposals seek to examine and resolve the following issues:

(1) Are investors in securities adequately protected by

COMMITTEE ON SECURITIES AND EXCHANGE (Australian Government Publishing Ser-vice 1974) [hereinafter RAE REPORT]. This Act was followed by comparable, althoughnot identical, legislation in South Australia in 1979. All this legislation was supersededby the Securities Industry Act, 1980, AUSTL. ACTS P. No. 66.

31 Submission to the Ontario Securities Commission on Bill 75, the Securities Act,1974, Toronto Stock Exchange 34 (Oct. 11, 1974), cited in Connelly, The Licensing ofSecurities Market Actors, in 3 PROPOSALS FOR A SECURITIES MARKET LAW FOR CA-NADA 1265, 1273 n.15 (1979).

32 REVIEW, supra note 1, paras. 2.1-.5.33 Id. para. 2.2.

34 See, e.g., M. FRIEDMAN, CAPITALISM AND FREEDOM 145 (1962).35E.g., W. GELLHORN, INDIVIDUAL FREEDOM AND GOVERNMENTAL RE-

STRAINTS 144-52 (1956). But cf. M. FRIEDMAN, supra note 34, at 144-49 (noting thatregistration and certification more appropriately balance social costs and benefits thanlicensure).

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present licensing arrangements? Is the reasonably well-in-formed investor acting with reasonable caution apt to sufferserious losses as a result of dishonesty or incompetence byoperators in the securities industry?

(2) Is continued occupational regulation of participantsin the securities industry justified? If so, what type of regu-lation is appropriate - registration, certification, orlicensing?

(3) If licensing is to be retained - who should be li-censed - principals, or representatives, or both? What cate-gories of license holders are appropriate? What criteria arerelevant in determining licensing categories? What exemp-tions, if any, should apply to licensing? Should restricted orconditional licenses be granted?

(4) Who should perform the licensing function - agovernment instrumentality or a self-regulatory organiza-tion? If self-regulatory organizations do undertake a licens-ing function, what checks and balances should be applied tothem?

(5) What criteria should apply to the grant of variouscategories of licenses?

(6) Is it possible to justify prudential controls on licenseholders? If so, on what basis should they be applied?

(7) What provisions should be made for monitoring andenforcing the conduct of license holders and their compliancewith licensing provisions? Who should perform the enforce-ment function?

(8) What types of misconduct would give rise to disci-plinary action against a license holder? What disciplinaryactions are appropriate for specific types of misconduct?What criteria should be used to determine whether a licenseis to be suspended or revoked? 6

Designed to ensure efficiency, the Australian recommendationssuggest that their main achievement is to redistribute the existing regu-latory burden away from the Commission regulators and toward theSROs.

2.3. The Drafting of the Regulation

The preparation of the regulation proposed in the Review raises

6 REVIEW, supra note 1, para. 1.4.

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significant questions. Economic and social theory, as well as practicalexperience, show that legislation and administrative rules, once drafted,often unintentionally favor the regulated. At the drafting stage, expertevidence, input, and experience is required. This is normally availableonly from the regulators, and the existing professional associations andtheir members, based upon their own experience as sellers of theservice.

Any legislative action based on the Review should attempt to en-sure the representation of all who may be interested. These uninten-tional biases need to be counterbalanced by groups other than the prov-iders of these services, such as consumer/user groups and commissionedexperts such as economists, academics, and others with different andsometimes wider perspectives. Yet, consumer/user groups generallylack the numbers, authority, and experience to get involved, especiallyin the area of technical and specialized legislative development. Nor canone expect the biases to be corrected by politicians or by the advisersresponsible for drafting the legislation or administrative action, as they,like most experts, are not trained to recognize the ramifications of thelegislation. Politicians will not intervene to correct the proregulationbias if no opposition is perceived.

3. THEORIES OF OCCUPATIONAL LICENSURE IGNORED

Although the Review sets out the strengths and weaknesses of self-regulation, 7 it overlooks the wealth of recent studies of the effects ofself-regulation. These studies conclude that self-regulation may lead tocartelization for existing members of the regulated group by raising in-comes of the regulated, both by reducing their supply and, if consumersperceive licensing as raising competence, by increasing the demand fortheir services.3

Occupational licensing generally results in barriers to entry in theform of requirements of qualifications and apprenticeship. It also re-stricts advertising, pricing, and client relations. It may further result in

37 Id. paras. 10.8-.10.31 M. FRIEDMAN, supra note 34, at 136-60; W. GELLHORN, supra note 35, at

105-51; G. STIGLER, THE CITIZEN AND THE STATE (1975); Benham & Benham, Reg-ulating through the Professions: A Perspective on Information Control, 18 J.L. &ECON. 421 (1975); Maurizi, Occupational Licensing and the Public Interest, 82 J.POL. ECON. 399 (1974); Duggan, Occupational Licensing and the Consumer Interest,in A. DUGGAN & L. DARVALL, CONSUMER PROTECTION LAW AND THEORY 163,168-70 (1980); Moore, The Purpose of Licensing, 4 J.L. & ECON. 93 (1961).

39 See generally M. FRIEDMAN, supra note 34, at 137-60 (discussion of socialeffects of licensure); W. GELLHORN, supra note 35, at 112-18 (comparing U.S. licen-sure system with medieval guilds).

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the creation of a fund to compensate clients affected by dealing withmembers of the licensed group.40 In short:

The thrust of occupational licensing, like that of theguilds, is toward decreasing competition by restricting accessto the occupation; toward a definition of occupational pre-rogatives that will debar others from sharing in them; to-ward attaching legal consequences to essentially private de-terminations of what are ethically or economicallypermissible practices.41

Occupational licensing authorities exercise considerable controlover licensees through the power to delicense, the power to enforce ad-herence to often anticompetitive codes of ethics, and the power to sup-press information, new products, and new services.

3.1. Types of Occupational Licensure42

The Review outlines the four forms of occupational regulation,"'

40 See generally REVIEW, supra note 1, paras. 1.0-.38 (general discussion ofobjectives of licensing participants in the Australian securities market); Connelly, supranote 31, at 1269-76 (discussing goals of licensing of securities market actors); Benham& Benham, supra note 38, at 421 (discussing effects of regulation of professions gener-ally); Duggan, supra note 38, at 178-80 (evaluating role of compensation scheme withlicensure system).

41 W. GELLHORN, supra note 35, at 114.' Why target securities professionals?Chapter 5 of the REVIEW sets out the four objectives of licensing extracted from

the U.K. GOVERNMENT REPORT, FINANCIAL SERVICES IN THE UNITED KINGDOM -

A NEW FRAMEWORK FOR INVESTOR PROTECTION (1985) [hereinafter GOWER RE-PORT] as efficiency, competitiveness, confidence, and flexibility. REVIEW, supra note 1,para. 5.2. These mirror the standards of "efficient, competitive and informal markets"set out in the Companies (Acquisition of Shares) Act, 1980, AUSTL. ACTS P. No. 65, §59, and those advanced in the RAE REPORT:

(i)... to maintain, facilitate and improve the performance of thecapital market in the interests of economic development, efficiency andstability.

(ii)... to ensure adequate protection of those who invest in the se-curities of public companies and in the securities market.

RAE REPORT, supra note 30, at 16.15.More searching justifications for the imposition of legal liabilities on market trans-

actors have been set out in Lodge & McCauley, Walking the Tightrope: The Compre-hensive Liabilities of Securities Professionals in the United States, 5 J. COMP. Bus. &CAP. MKT. L. 267, 268-70 (1980). The justifications are: (1)"Access" or "Passkey"theory, by which securities markets constitute a valuable resource which if disruptedwill affect investor confidence. Pressure for enforcement of securities regulation accord-ingly should fall on the securities professionals who control access to the market andwho are obliged to ensure that the market remains fair and orderly. (2) "Super Fiduci-ary" theory, by which, because of the disparity in expertise between clients and securi-ties professionals, the professionals owe fiduciary duties which predominate over their

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but nowhere does it consider the option of no action or no regulation.Unfortunately for the consumer/user sovereignty case, governments,commissions, and regulators do not receive credit for doing nothing.These options are discussed hereunder.

3.1.1. Registration44

When widespread noncompliance and the subsequent failure of aprivately operated Registry resulted in the abolition in the early 1980sof the Registry of Business Names in the U.K., and thus the disclosureof the names of natural persons behind the business name, the questionwas raised whether such registration had ever been to anyone'sbenefit.4

5

If there is no provision surrounding the denial of the right to en-gage in the registered activity, competitive forces are unaffected, al-though in practice qualifying conditions are usually required forregistration.'6

3.1.2. Certification47

Certification by a tribunal, government, industry, or private bodyindicates possession of certain skills but does not or should not preventaccess to the market by uncertified persons. Hence, a registered builderor licensed contractor can coexist with any other builder or contractor,as can an accountant (Certified Public or Chartered Accountant) along-side any other accountant. At a certain level barriers to entry and theresulting expense would be ignored by those in the industry.

Certification without licensure has the advantages of protectionagainst monopolization or cartelization by the industry; satisfying thelicensure paternalism arguments;"8 providing information to users; evi-dencing compliance with declared standards of skill and training assome proof of expertise; and not foreclosing the development of skills bynewcomers, nor leaving "the door of opportunity open for [persons]

contractual duties. Good character is especially relevant when an occupation is the sub-ject of regulation in the public interest. See also W. GELLHORN, supra note 35, at 129.Securities professionals also owe a duty to government and to the securities markets. (3)"Source of Money" theory, by which liability is imposed on securities professionals forthe practical reason that they are often the continuing solvent person, "insurer", or"deep-pocket", and thus through them risk is effectively spread.

43 REVIEW, supra note 1, paras. 5.4-.8." See id. para. 5.5."See generally GowER REPORT, supra note 42.4 Id."I Id. para. 5.6.1, M. FRIEDMAN, supra note 34, at 149.

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who are occupationally gifted though not conventionally schooled."149 Ofthe four options considered, certification is most consistent with a com-petitive market and a consumer sovereignty. 50 As such, certificationwarrants further consideration in the Review rather than the cursorydismissal received.

3.1.3. Licensing51

Any scheme of licensing must return to first principles and be apreventive measure to guard users from victimization rather than aneconomic weapon intended to strengthen the licensees.52 It must notaffect consumer sovereignty. The very weakly presented case againstlicensing53 does not address Friedman's paternalism argument:

Individuals, it is said, are incapable of choosing theirown servants adequately, their own physician or plumber orbarber. In order for a man to choose a physician intelli-gently, he would have to be a physician himself. Most of us,it is said, are therefore incompetent and we must be pro-tected against our own ignorance. This amounts to sayingthat we in our capacity as voters must protect ourselves inour capacity as consumers against our own ignorance, byseeing to it that people are not served by incompetent physi-cians or plumbers or barbers."

Nor does the Review draw a distinction between instances wherelicensing may be justified, namely, in the "special case which ariseswhen an occupation of critical public importance has been overrun, andnot merely occasionally infected, by persons insensitive to their respon-sibilities." 55 There is no evidence of widespread failure of Australiansecurities professionals beyond the failures in the 1960s reported in the

49 W. GELLHORN, supra note 35, at 148.50 Cf M. FRIEDMAN, supra note 34, at 145 (registration is most consistent with

liberalism).5' REvIEw, supra note 1, para. 5.7.52 Id. para. 5.28.51 Id. para. 3.31 (discussing burgeoning growth leading to "a flood of paper," a

breakdown in the ability of the NCSC (National Companies and Securities Commis-sion) to monitor licensing provisions, and other administrative difficulties). The RE-vIEw reports that "[t]he Commission noted with interest that many of the submissionsexpressed concern about the conduct of license holders rather than the licensing systemitself." See also id. paras. 5.9-.28 (discussing factors which lead the NCSC to recom-mend licensing in spite of the fact that it is typically anticompetitive).

" M. FRIEDMAN, supra note 34, at 148.51 W. GELLHORN, supra note 35, at 145.

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Australian Rae Report."6 Where user choice is wide, the argument forlicensing - whether by external regulation or by self-regulation - isweak.

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The argument for licensing is stronger where the user cannotchoose who will serve him, or arguably where the user is too distant toknow the facts about his servant (such as dealing with a securities pro-fessional). However, the existence of such evils must be demonstratedand proved, rather than being based on the suppositions underlying theReview.

3.1.4. Negative Licensing

The jurisdiction of an authority such as the Commission or a li-censing tribunal to issue or to obtain an order prohibiting a personfrom engaging in an occupation for breach of a rule or for unacceptableconduct is an option that deserves consideration. Such power would becompatible with the consumer sovereignty theme of this paper, andneed not involve the entrenchment of the SROs or other industrygroups as proposed in the Review.58

4. RAMIFICATIONS OF REGULATION BY SELF-REGULATORY

ORGANIZATIONS

The U.S. Congress has placed great emphasis on the self-regula-.tion of market actors in the securities industry, through both adminis-trative and judicial supervision of stock exchanges and of securities in-dustry professional associations.59

In contrast to the self-regulation in the U.K., where compliance isvoluntary and where there is not really the possibility of U.K. govern-ment intervention by statute, 0 the U.S. and Canadian schemes, as wellas the proposed Australian self-regulation scheme, are not independentof some external accountability and outside supervision. 1 Such inter-

5' See supra note 30.57 REVIEW, supra note 1, para. 5.8.51 See id. para. 5.10-.13.5' See Securities Exchange Act of 1934, 15 U.S.C. § 78a(a) (1982) (conferring

exclusive jurisdiction over violations of the Act and the rules promulgated under it tothe U.S. district courts); see also Sutter v. Groen, 687 F.2d 197 (7th Cir. 1982) (fed-eral courts have jurisdiction to adjudicate alleged violation of an SEC rule prohibitingdeceptive practices in the purchase and sale of securities).

60 REVIEW, supra note 1, para. 10.17.*' Section 78o of the Securities Exchange Act of 1934 contains the primary provi-

sions regarding broker-dealer registration and administration. In particular, Section78o(b)(4) authorizes the SEC to censure, to place limitations on the activities, or tosuspend or revoke registration of any broker or dealer, especially in subsection (A)where there has been a willful violation of the securities legislation or regulations. Sec-

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vention is arguably very important in order to ensure that self-regula-tion works, as government must be assured that the SROs actually per-form their regulatory functions.62 Regulation also must replaceimpairment of competition, and supervision of a quasi-public utility isnecessary for efficiency. 3

Self-regulation is perceived as having the benefit of "the expertiseand intimate familiarity with complex securities operations whichmembers of the industry can bring to bear on regulatory problems, andthe informality and flexibility of self-regulatory procedures."'" The

tion 78s of the Act and the associated rules provide for SRO registration and responsi-bilities, and for SEC oversight of SROs.

Section 78o-3(b) of the SEC Act sets the criteria which the SEC must considerprior to approval of a national securities association of an association of brokers anddealers.

(1)The association must have the organization and capacity to carry out the pur-poses of the Act, and must be able to comply with, and to enforce compliance with, theAct by its members and persons associated with its members. § 78o-3(b)(1).

(2)The rules of the association must provide that any registered broker or dealermay become a member. § 78o-3(b)(3) (subject to subsection (g) of this section).

(3)The rules of the association assure a fair representation of its members in selec-tion of directors and administration of its affairs. § 78o-3(b)(4).

(4)The rules of the association provide for the equitable allocation of dues, fees,etc., among members. § 78o-3(b)(5).

(5)The rules of the association foster equitable principles of trade, and aredesigned to prevent fraudulent and manipulative acts and practices. § 78o-3(b)(6).

(6)The rules of the association provide for appropriate disciplining of membersand accounted persons, § 78o-3(b)(7), and provide a fair procedure for such discipline.§ 78o-3(b)(8).

(7)The rules of the association do not impose any burden on competition. § 78o-3(b)(9).

Self-regulation of stock exchanges is built into the Australian securities industry bythe Securities Industry Act, 1980, AUSTL. ACTS P. No. 66 and Codes. This legislationallows for the continuation of stock exchange rules and procedures, subject to overridingCourt and/or Commission sanction under sections 14, 42. Securities Industries Act,AUSTL. ACTS P. No. 66, §§ 14, 42. However, the SRO proposal, subject to overridingMinisterial Council and/or Commission supervision, does not fully address the carte-lization issue and the potential windfall of the self-regulated. The REVIEW gives noconsideration to alternatives to licensing - why regulate or self-regulate at all? - whynot ensure the market works competitively and regulates itself? See REVIEW, supranote 1. Nor does the REVIEW stress that membership of an SRO is not proposed as aprecondition to the holding of a proposed Securities Industry License or that regulationby the Commission (as a kind of SRO) would continue alongside the proposed SROs.Cf id. paras. 10.44(a), 10.46, 10.55, 10.64.

6'2 Dey & Makuch, Government Supervision of Self-Regulatory Organizations inthe Canadian Securities Industry, in 3 PROPOSALS FOR A SECURITIES MARKET LAWFOR CANADA 1399, 1442 (1979) (citing SEC, 4 REPORT OF THE SPECIAL STUDY OFSECURITIES MARKETS, H.R. Doc. No. 95, 88th Cong., 1st Sess. 501 (1963)).

8 Id. at 1442-43.6' SENATE SUBCOMM. ON SECURITIES, COMMITTEE ON BANKING, HOUSING AND

URBAN AFFAIRS, SECURITIES INDUSTRY STUDY, 93rd Cong., 1st Sess. (1973), cited inMerrill Lynch, Pierce, Fenner & Smith, Inc. v. National Ass'n of Securities Dealers,Inc., 616 F.2d 1363, 1366 (5th Cir. 1980).

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transfer of the administrative workload from a government agency tothe SRO itself can save money for the public sector and thereby enablemore effective use of government resources.

Several questions arise, however, especially with respect to exter-nal surveillance of the adequacy of self-regulation. These questionshave not been fully addressed in the Review, yet they highlight dangersto be borne in mind when considering the effectiveness of self-regula-tion. In the Report of the Windfall Royal Commission, Justice Kellyobserved that self-regulation on the Toronto Stock Exchange prior tothe introduction of external supervision of the Exchange displayed thefollowing three weaknesses: (1) the rulemaking did not keep pace withloopholing deficiencies in the rules; (2) there was widespread aberra-tion from strict observance of the spirit of the rules; and (3) there was"woeful lack of any effective surveillance to ensure the adherence torule."

65

Because of these weaknesses, any review of SROs must ensure dis-closure of information on the SRO internal operations. In particular,because of the public utility function of SROs, there must be publicaccountability. The question is, to whom? The Commission? The pub-lic? The legislature? With the legislated status of an SRO goes publicaccountability and responsibility.

The Australian proposal to pass management of the SRO legisla-tion/administrative action to the industry requires careful considera-*tion. The justification for handing over administration to the recognizedexperts, if the industry so qualifies, has immediate appeal in that itavoids political patronage and partisanship and ensures expert and in-formed administration.66 However, this inevitably leads to control bythe regulators. For example, in 1956, Professor Walter Gellhorn statedthat seventy-five percent of U.S. occupational licensing boards werecomposed exclusively of licensed practitioners of the respective occupa-tions who, by definition, had an economic interest in many of the thedecisions they made concerning admission requirements and standardsto be observed by licensees.6 7 As with the SRO plan, the licensingboards directly represented organized groups within the occupation andwere often nominated by the industry for self-regulation. 8

Even if the industry experts do not have a majority of places on

'5 ONTARIO ROYAL COMMISSION, THE WINDFALL REPORT 100 (1965), cited inDey & Makuch, supra note 62, at 1428. The Windfall Report was the result of aninquiry into the trading of Windfall Oils and Mines limited shares, with an eye to-wards evaluating the role of the government in supervising the operation of SROs.

" See, e.g., RAE REPORT, supra note 30, at 16.12-.13.67 W. GELLHORN, supra note 35, at 140.68 Id.

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the regulatory board, representatives of other related professionalgroups such as accountants and lawyers tend to outnumber any lay orconsumer representatives who often lack sufficient knowledge or confi-dence to provide a view to balance that of the experts.

The legislation/administrative action proposed appears to fit thepattern of this model with the expected biases towards the industry andits regulators. Indeed, the Australian Commission regularly boasts of itsclose and satisfactory relationship with the securities industry.69

The Review contains no view opposing that of the regulators (theCommission proposal and the proposed SROs), and the "checks andbalances"'70 provide only limited control over the naturally self-seekingoperation of the proposed SROs.

Any review of SROs must address the powers of the government,through the Commission, to regulate SROs in the public interest. Inparticular, the following anticompetitive and jurisdictional issues mustbe considered.

4.1. Anticompetitive Factors

Section 15A(b)(9) of the Securities Exchange Act of 1934 requiresfor SEC approval as an SRO evidence, inter alia, that the rules of theassociation do not impose an inappropriate burden on competition.7 Ina similar vein, the Review lists the following criteria to be satisfiedbefore an SRO may be approved by the Australian Commission:

(a) demonstrating that it would be capable of properlyexercising its functions as a securities industry SRO, beingthe functions of regulating its affairs in the interests of thepublic and of administering and enforcing its business rules;

(b) that, if it will operate other than an approved secur-ities industry SRO -

(i) its operations will not interfere with its opera-tion as a securities industry SRO; and

(ii) its business rules provide for a separate class ofmembership for a person to whom its operation as asecurities industry SRO relates whether or not such aperson may be a member within another class ofmembership;

(c) that its business rules make satisfactory provision -

:9 See REVIEW, supra note 1, paras. 10.3, 10.42.70 See, e.g., id. paras. 1.6, 2.1, 10.43-.46.71 Securities Exchange Act of 1934, 15 U.S.C. § 78f(b)(8) (1982).

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(i) for the admission as members of persons li-censed or proposing to apply to be licensed under theAct, or a specified class of such persons;

(ii) for the standards of training and experience,and other qualifications, for membership;

(iii) for the manner in which members are to con-duct their business of dealing in or advising on securi-ties so as to ensure efficient and honest practices in re-lation to that business;

(iv) for the exclusion of a body corporate frommembership where a director of the body corporate, aperson concerned in the management of the body corpo-rate or a person who has control, or substantial control,of the body corporate would himself be excluded frommembership (except where that exclusion would bebased upon an educational requirement);

(v) for the exclusion from membership of a personwho is not of good character and high businessintegrity;

(vi) for the expulsion, suspension or disciplining ofmembers for conduct inconsistent with just and equita-ble principles in the transaction of business or for acontravention of or failure to comply with the businessrules of the proposed securities industry SRO or theprovisions of this Act;

(vii) for an appropriate mechanism whereby a per-son aggrieved by the refusal of an application for mem-bership or by any of the actions referred to in subpara-graphs (iv), (v) and (vi) may appeal to an independentbody in respect of the refusal or action;

(viii) for the inspection and audit of the accountingrecords of members required to be kept by the Act."

Comprehensive as they appear, it remains to be seen whether thesecriteria accord with the U.S. experience, and, in particular, whetherregard has been paid to the following competitive criteria set forth di-rectly below.

4.1.2. Restrictions on Entry

Will the proposed self-regulation readily allow a qualified or ex-

72 REVIEW, supra note 1, para. 10.43.

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perienced person (such as a dealer qualified and/or experienced over-seas) to be granted a securities industry license?

Economic theory suggests that occupational regulation favors ex-isting members to the detriment of aspiring members. New regulationtends to entrench existing members, restrict numbers, and raise incomesand costs to users whether or not the users gain any benefit from theregulation.73 Existing members benefit further because they do not payfor the new regulations and the extra requirements.

The extra requirements proposed for aspiring securities industrylicensees fit this anticompetitive model by erecting barriers to entry.The existing members qualify for a license on two years experience inthe industry; aspiring members will be required at least to attend acourse involving 100-120 teaching contract hours provided by institu-tions yet to be determined. 4 While there is some merit in the proposedrequirement of formal studies in law and economics, what safeguard isproposed to ensure that this course does not serve anticompetitivepurposes?

4.1.3. Code of Behavior! Code of Ethics

Will the proposed code of behavior/code of ethics to be promul-gated 5 allow for free play of market forces?

Economic theory shows that such codes are usually anticompetitiveand paternalistic in that they (1) prevent elaborate and attention-seek-ing advertising; (2) prevent poaching by competitors; (3) disadvantagenew entrants to the industry who cannot advertise; (4) restrict informa-tion for users; and (5) deny consumer sovereignty by denying the con-sumer the option to decide just what the consumer wants.7 1

The Review proposes to give the SRO the right to regulate theconduct of its members, but no user benefit is stated. 7 Only if SROmembership is not a prerequisite to carrying on business as a securitiesprofessional could these powers be given to an SRO. Market forceswould then operate to maintain competition. The user must retain thefreedom to choose based upon relevant full information and knowledgeof the options.

71 See Duggan, supra note 38, at 172."I See REVIEW, supra note 1, paras. 7.5, 7.12. But see id. para. 7.18 (acknowl-

edging that experience requirements should take account of "barrier to entry"considerations).

75 Id. paras. 10.43(c)(iii), 10.52.71 See, e.g., Duggan, supra note 38, at 174-75.7 REVIEW, supra note 1, para. 10.53; see also id. para. 10.56 (recommending

that SROs monitor and review the financial position and reports of their members).

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4.1.4. Quality and Price of Service

The Review does not promote the development of new productsand services.7 Are these to be encouraged, or are they to be restrictedand regulated by the business rules of the proposed SROs presumablyto the advantage of the existing suppliers and their products? Are theSROs to have control of prices, commissions, and so forth, so as tomaintain a "reasonable" return to members in times of economic down-turn? Are recommended prices to be permitted insofar as they are per-mitted under competition legislation? An effective and competitive sys-tem of self-regulation must address these questions.

4.1.5. Compensation Fund

The proposed national fidelity fund would appear to provide acertain and fairly complete protection for investors.79 It must, however,be remembered that contributions to the fund will have a social cost ifnot related to the risk of default or other fraudulent practices. To befair to contributors, the fund must be regulated by the market test ofsimilar "insurance" schemes.

4.2. Commission Must Have Sufficient Regulatory Powers OverSROs

Theories of regulation indicate the ease with which regulationcomes to the benefit of the regulated.80 Attention must be paid to en-sure control is beyond that of the industry/interest groups which willform SROs.

Has the Commission and/or the Ministerial Council sufficientpower to regulate SROs? Has thought been given to how best to gaugeand enforce the interests of the public generally and users specifically?Have class action/representative actions been considered for their use-fulness as an enfranchising device?

The Review goes some way towards articulating the propositionthat it is important, for reasons of competition and control, that SROsanswer not to themselves but to the external Commission as some bal-

78 See id. paras. 3.22-.29.79 See id. paras. 8.107(c), -.111, -.112.SO See supra notes 37-56 and accompanying text (analyzing the four types of oc-

cupational licensure discussed in the REVIEW and their tendency to increase the mo-nopoly position of existing members); see also infra notes 110-18 and accompanyingtext (discussing the REVIEW'S failure to address the central aspects of economic theoriesof regulation).

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ance to the natural gravitation towards self-gratification."' Nonetheless,serious lacunae are evident in the proposed regulatory scheme.

4.2.1. Commission Must Be Assured That SROs Actually PerformTheir Regulatory Functions

In the absence of performance of regulatory functions by theSROs, the facade of self-regulation will be worse than no public protec-tion at all. Hence, regulation should revert in such instances to the gov-ernment or the Commission. The Review, cognizant of this issue, pro-poses to endow the Ministerial Council with the power to cancel SROapproval.8 2

While Section 42 of the Securities Industry Act and Codes,8 3 em-powering the court to order observance or enforcement of stock ex-change business rules or listing rules, provides the model for Commis-sion oversight of SROs, U.S. law gives significantly greater powers tothe SEC to supervise SROs. SRO administrative disciplinary proceed-ings are subject to SEC oversight.8 ' Written conclusions of an SROmust be filed with the SEC, which may review the matter on its ownmotion or on the motion of an aggrieved party.8 5 The SEC can thenaffirm or modify an SRO sanction, or remand to the SRO for furtherconsideration. 8

4.2.2. Power to Suspend or Cancel SRO Approval

The Australian Commission should have the power to suspend orcancel SRO approval in line with the power of the Ministerial Councilto approve and therefore to disapprove a stock exchange under the Se-curities Industry Act and Codes Section 38. Similarly, the power tosuspend or revoke registration, to censure, or to impose limitations onSRO activities, when after notice and opportunity for a hearing anSRO has been found to have violated the law, could be strengthened inline with Securities Exchange Act Section 19(h)(1).8 '

11 REVIEW, supra note 1, para. 10.44 (discussing the structure of a statutoryframework for governing SROs); see, e.g., id. para. 10.34 (summarizing several posi-tions opposing self-regulation by SROs).

82 Id. para. 10.44(a).83 Securities Industry Act, 1980, AUSTL. AcTs P. No. 66, § 42.84 Securities Exchange Act of 1934, 15 U.S.C. §§ 78s(d), (e) (1982).88 Id. § 78s(d)(1), (2).a Id. § 78s(e)(1), (2); see also Application of Wall Street West, Inc., Exchange

Act Release No. 18, 320, [1981-1982 Transfer Binder] Fed. Sec. L. Rep. (CCH) % 83,069 (Dec. 9, 1981) (findings of violation and sanctions by NASD exchange upheld bySEC).

8" 15 U.S.C. § 78s(h)(1) (1975). See generally Lipton, Governance of Our Securi-

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4.2.3. Publication of SRO Particulars

Information is required for an informed market, and the proposalto notify officially and publicly details of SRO approval, suspension,and cancellation is an important means of informing the market.88

4.2.4. Appeal to the Court by SRO Members

Persons whose membership in an SRO is denied or otherwise af-fected should have the right of appeal to an outside body such as theCommission or the courts. This principle is important to ensure outsideredress, and as another balance to the natural gravitation of the regu-lated to self-gratification.

Securities Exchange Act Section 25 gives a person aggrieved by afinal order of the SEC recourse to the U.S. Court of Appeals.8" Simi-larly, in Canada, the Toronto Stock Exchange (TSE) is supervised bythe Ontario Securities Commission (OSC). The Australian schemeshould make available such an outside appeal.

4.2.5. Notification to Commission of Amendments to SRO BusinessRules

The proposed procedure for notification of amendments to SRObusiness rules parallels in part the existing procedure for notification ofamendments to stock exchange business rules.9" The proposal, however,contains no public interest requirement as a basis for amendment,92 andthe apparently arbitrary but very short period of twelve days is recom-mended."' The public interest requirement and more manageable

ties Markets and Failure to Allocate Regulatory Responsibility, 34 CATH. U.L. REV.397, 401-08 (1985) (discussing sanctions against SROs in the context of the division ofregulatory authority between the SEC and the exchanges themselves).

88 REVIEW, supra note 1, paras. 10.57-.58; see also id. para. 10.44(b) (outliningthe notification requirement as part of the overall statutory framework).

s9 See, e.g., Sorrell v. SEC, 679 F.2d 1284 (9th Cir. 1982); Sirianni v. SEC, 677F.2d 1323 (9th Cir. 1982).

so The Ontario Securities Commission (OSC) must recognize the Toronto StockExchange (TSE) in writing before the TSE can operate as an exchange. Regardinggovernance, the OSC can make any directive, etc., on the activities of the TSE, orrelating to the internal rules of the TSE. As a review procedure, the OSC can hearappeals from TSE decisions by any person affected. Securities Act, ONT. REV. STAT.ch. 466, § 9.1(22) (1980), amended by ONT. REV. STAT. ch. 59 (1984); Dey &Makuch, supra note 62, at 1443.

*' Securities Industry Act, 1980, AUSTL. Acrs P. No. 66, § 39.s See, e.g., id. § 38(2)(d).

Compare id. § 38(2)(d) with id. § 39(3) (allows 21 days for publication ofamendments to exchange rules before the amendment ceases to have effect for failure ofpublic notice).

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twenty-one day notice period of the Securities Industry Act and Codesshould both be included in the proposed scheme.

4.2.6. Power of Investigation

The power of investigation by the Commission into SROs andtheir activities would be an important factor in its administration ofSROs and their self-regulation. Presumably, the Securities IndustryAct Codes would authorize such investigation.94

The powers of the SEC provide a useful comparison and a modelfor development of the powers of the Commission. The SEC is empow-ered, under Section 21 of the Securities Exchange Act, to investigatepossible violations of securities laws.95 If the investigation discloses vio-lations by brokers/dealers or investment advisers, the SEC can proceedunder Section 15(b)(4) of the Securities Exchange Act to invoke disci-plinary measures, such as censure, limitation of activities, suspensionfor up to one year, and revocation of registration.98 To so proceed, theSEC must show that the firm or individual willfully made a materialmisstatement to the SEC, willfully violated the securities acts, or will-fully aided or abetted the violation of such statutes. 97

4.2.7. Power to Discipline Related Persons

Does the Commission's power of discipline over SROs extend topersons associated with a member of an SRO? In the U.S., the SECcan discipline persons associated with an SRO member firm by sus-pending or barring such persons from association with members of theorganization. 8

The paragraphs in the Review addressed to discipline of securitiesprofessionals do not consider whether those once removed, such as law-yers, investment bankers, and spouses, should also fall within the Com-mission's disciplinary net. Presumably, they could be subject to suchdiscipline under other legislative sources, such as the penalty provisionsof the Securities Industry Act and Codes.99 The Review also fails to

Id. §§ 15-36 (Investigations).,5 15 U.S.C. § 78u(a) (1975) (broad authority and discretion given to SEC to

investigate violations)." Id. § 78o(b)(4). The SEC can also bring suit in the district court to enjoin

behavior "[w]herever it shall appear . . . that any person is engaged or is about toengage in acts ... constituting a violation of exchange rules .... " Id. § 78u(d).

" Id. § 78s(c)(4)(A), (D), (E).9s Id. § 78s(h)(3)." See, e.g., Securities Industry Act, 1980, AusTL. ACTs P. No. 66, § 42 (1980)

(giving the court power to enforce rule of the exchange against "any person under anobligation to comply with, observe, enforce or give effect to ... the rules of ... [the

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consider the question of persons associated for various breaches speci-fied.1 0 The discipline of related persons must be further addressed byany comprehensive regulatory scheme.

4.2.8. Power to Ensure That SRO Rules Are Just And Equitable

The Review recommends that the business rules of a proposedSRO require the "just and equitable" conduct of SRO members andthe carrying on of business "with due regard for the interests and pro-tection of the public." 101

Are these requirements stated with sufficient strength or is "satis-factory provision" too elusive a standard? Section 15A(b)(6) of the Se-curities Exchange Act states the U.S. equivalent more boldly when itsays that "[a]n association . . . shall not be registered . . . unless the[SEC] determines that. . . (6)[t]he rules of the association are designedto prevent fraudulent and manipulative acts and practices, to promotejust and equitable principles of trade."' 2 Similarly, the U.S. exchangesare under the same obligations to establish rules to further "just andequitable principles of trade"' 03 and to enforce compliance with suchrules.' o4

4.3. Commission Must Have Power to SuspendlRevoke SecuritiesIndustry License

The Review proposes the granting of power to the Commission torevoke a Securities Industry License. 05 It also proposes the legislationbe drafted so as to impose no obligation on the Commission to divulgeinformation on request.0 8 This seems unduly authoritarian in thesedays of administrative law and freedom of information, and no case forsuch heavy-handed secrecy has been advanced.

Comparison can be made with Securities Exchange Act Section19(h)(2) which retains for the SEC - regardless of the position of theSRO - the upper hand of license suspension if in the public interest,

exchange] . . . "); id. § 128 (forbidding insider trading by several classes of people,and allowing sanctions against the same).

100 See, e.g., REVIEW, supra note 1, paras. 9.28-.30 (discipline provisions limitedto representatives or employees of representatives within the securities industry); id.paras. 10.59-.60 (disciplinary action by the associations only considered in relation tomembers).

101 REVIEW, supra note 1, para. 10.43(c)(vi), (x).102 15 U.S.C. § 78o-3(b)(6) (1975).103 Id. § 78f(b)(5).104 Id. §§ 78f(b)(1), (6), 78s(h)(1).105 REVIEW, supra note 1, para. 9.6 (Recommendation 9.1).110 Id. para. 9.32 (Recommendation 9.7).

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for the protection of investors, and/or for the purposes of thelegislation.

10 7

4.4. SROs Must Have Sufficient Powers to Regulate their Members(Subject to Commission Oversight)

The Review proposes that SROs share with the Commission in theadministration of discipline of their members, and touches upon thescope of SRO regulation. 0 8

The level of SRO obligation of enforcement is not specified, how-ever,10 9 and it is suggested that attention be paid to the following twoquestions on the scope of the SRO authority. (1) Must SRO rules pro-vide for discipline of members? Securities Exchange Act Section15A(b)(7) requires that SRO rules provide that members, and personsassociated with members, be disciplined for violation of securities law"by expulsion, suspension, limitation of activities, functions and opera-tions, fine, censure, being suspended or barred from being associatedwith a member, or any other fitting sanction." 10 (2) Must SROs en-force compliance by members with securities law? Again, SecuritiesExchange Act Section 15A(b)(2) requires that the association have thecapacity "to enforce compliance by its members and persons associatedwith its members" with securities legislation. 11

5. ECONOMIC THEORIES OF REGULATION

The Review proposes new initiatives. Delegation of the adminis-tration of broker-dealers who are SRO members to the SRO qualifiedself-regulation, and inclusion of previously "exempt" dealers (banks,insurance companies) warrant further study. As presented in this arti-cle, the ramifications of many of the issues, especially those withlengthy track records in North America, have been inadequately as-sessed. Nowhere does the Review consider whether the proposed quali-fied self-regulation could provide any improvement over the currentsystem of licensing, with minor supervision by Australia's eight Corpo-

107 15 U.S.C. § 78s(h)(2) (1976).108 REVIEW, supra note 1, para. 10.61 (Recommendation 10.7).109 See id. para. 10.43(c)(iii), (v), (vi) (Recommendation 10.1).110 15 U.S.C. § 78o-3(b)(7) (1976).111 Id. § 78o-3(b)(2); see also id. § 78s(g)(1)(A) (a registered national securities

exchange must enforce compliance with its rules by its members and their associatesunless there is a reasonable justification or excuse for non-enforcement); cf. Baird v.Franklin, 141 F.2d 238 (2d Cir. 1944) (stating that New York Stock Exchange "vio-lated a duty when it failed to take disciplinary action against [partner in a Stock Ex-change firm] after there was reason to believe that the latter had converted the plain-tiffs' securities.").

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rate Affairs Commissions (as delegates of the National Companies andSecurities Commission). Nor does it consider the alternative of no li-censing at all."1 ' Certainly the Review fails to address the breadth ofeconomic theory and literature dealing with the costs, effects, and bene-fits of regulation and self-regulation. 1 Accordingly, it reads in partslike the rather narrow-minded, black-letter consumerism reports char-acteristic of the 1960s and 1970s.

Presumably, the Review does agree with the basic proposition ofeconomic theory that voluntary exchange is mutually advantageous;that is why the buyer buys and the seller sells. The Review does notarticulate and does not seek to reinforce, advance, or confirm the as-sumptions underlying this proposition. These assumptions are that: (1)ignorance must be dispelled so that both buyer and seller are well-in-formed about the things exchanged; (2) there must be a perfect andefficient market, with no market imperfections impeding the flow ofresources into or out of the industry; (3) both parties know what theyprefer; and (4) individuals are the best judge of their own self-interest.

11 4

The Review, therefore, fails to address the central tasks of the the-ory of economic regulation, and does not explain who will receive thebenefits or burdens of the proposed regulation; nor does it explain thedetails, if any, on the maintenance of competitive forces and freedom ofentry in the proposed system of regulation. Its explanation is lacking aswell as to the effects of the proposed regulation on the allocation ofresources.1

1 5

By ignoring consideration of economic theories of regulation,1" 6 the

112 This alternative was in practice before the first Securities Industry Act waspassed. See, e.g., Securities Industry Act, 1970 N.S.W. STAT. No. 35.

113 See, e.g., AUSTL. LAW REFORM COMM'N, REPORT No. 16, INSURANCE

AGENTS AND BROKERS paras. 124-126, at 78-80 (1980).114 See, e.g., Parish, Industrial Censorship, 22 QUADRANT 12, 12 (1978).1'5 See Fels, The Political Economy of Regulation, 5 U. N. S.W. L.J. 29, 32

(1982).11I Several hypotheses concerning the effects of regulation are set out in Fels,

supra note 115, at 32-38.(a) The Consumer Protection Hypothesis. Under this hypothesis, regulation is

passed in response to the actual or potential failure of the market to protect consumerinterests. Traditionally, unquestioned areas of regulation included the legal profession,health care, and drug and product safety.

(b) The Perversion Hypothesis. This hypothesis states that, although the intendedpurpose of regulation is to protect consumers, the regulated industries ultimately "per-vert" their regulators. The result of this perversion is that the regulators come to iden-tify with the regulated and become the protectors of the regulated. But see Posner,Theories of Economic Regulation, 5 BELL J. ECON. & MGMT. Sot. 335, 341-42 (1974)(finding the "Capture Theory" unsatisfactory).

(c) The No-Effect Hypothesis. This hypothesis states that regulation achieves no

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Review fails to recognize that intervention allegedly made in the con-sumer interest is often perverse in its effects. It can be ineffective, orinefficient in achieving its purpose at high cost. Such failure can oftenbe traced to the following factors: 1) inattention to basic economic prin-ciples, and especially neglect or underestimation of the responses of theeconomic person who rationally pursues self-interest and reacts to in-centives and disincentives; 2) failure to explore the full consequences,including the incidental and remote consequences of the proposed regu-lation; and 3) disregard or underestimation of the cost of the proposedregulation.11

7

The Review does not articulate these economic assumptions, andfails to pay regard to the principle of consumer sovereignty characteris-tic of a democratic society. 1 8 The state, through its regulatory agencies,does not know better than consumers themselves about what is good forconsumers. Both parties - buyer and seller, government and governed- know what they prefer, and individuals are the best judges of theirown self-interest. Regulation in accordance with consumer sovereigntycan be justified only in certain instances, through well-tailored mecha-nisms. For example, it is appropriate to dispel ignorance so that thebalance is redressed to ensure that buyer and seller are well-informedabout the things exchanged. In brief, the intervention should be to sub-sidize not the regulation but the provision of information.' Interven-

significant effect beyond imposing compliance costs (e.g., filling in forms, having law-yers, and diverting management time from productive activities).

(d) The Producer Protection Hypothesis. Under this hypothesis, the effect of regu-lation is to increase or sustain the economic power of the regulated industry.

(e) The Theory of Economic Regulation. Under this theory, economic regulation --the coercive power of the government -- is a product whose allocation is governed bylaws of supply and demand. Viewed as a product supplied to interest groups ratherthan an expression of the social interest in efficiency or justice, regulation tends toconvert formerly competitive or oligopolistic industries into cartels. See Stigler, TheTheory of Economic Regulation, 2 BELL J. EcoN. & MGMT. Sci. 3 (1971); Posner,supra, at 343.

Fels also notes that the chief beneficiaries of regulation, and the primary forces inthe maintenance of regulation, are the regulators themselves. He concludes that this has"considerable appeal" as a possible hypothesis.

117 See Parish, supra note 114, at 13.18 See generally M. FRIEDMAN & R. FRIEDMAN, FREE TO CHOOSE (1980); J.S.

MILL, ON LIBERTY 6 (People's ed. 1865) ("The Sole end for which mankind arewarranted, individually or collectively, in interfering with the liberty of action of any oftheir number, is self protection . . . . Over himself, over his own body and mind, theindividual is sovereign."); A. SMITH, THE WEALTH OF NATIONS 458 (E. Cannan 5thed. 1930) ("The proposition [that the majority would prefer to pursue, unrestricted,their own economic ends] is so very manifest, that it seems ridiculous to take any painsto prove it; nor could it ever have been called in question had not the interested sophis-try of merchants and manufacturers confounded the common sense of mankind.").

119 See, e.g., Easterbrook & Fischel, Mandatory Disclosure and the Protection ofInvestors, 70 VA. L. REV. 669, 681 (1984) (noting that mandatory disclosure system is

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tion is also appropriate to correct market imperfections. For example,as the Review recognizes, the high cost of litigation discourages buyerredress for fraud or deception. In such a case, the solution is to reducelitigation costs to enable ready legal redress at the lower end of themarket, such as by establishment of a securities tribunal or the like, orby redefining the jurisdiction of the existing consumer-oriented SmallClaims Tribunals. 2 ° Finally, where a group such as stockbrokersachieves a natural monopoly, a comprehensive regulatory scheme mustensure that the competitive provisions of trade practices law apply andcontinue to apply to the group and to new groups in the industry."'

6. CONCLUSION

The National Companies and Securities Commission's review of Aus-tralia's licensing provisions in the securities industry is a detailed docu-ment covering many issues. It borrows many initiatives from NorthAmerican models, but sometimes fails to address basic policy issuessuch as the likelihood of cartelization for SRO members, the need forexternal constraints on SRO activities, and the necessity of maintainingand promoting Commission registration as a quasi-SRO in its ownright (as an alternative to dealing through an SRO). Thus, nowhereare the actual benefits and advantages of any registration stated; in thislight, the proposals in the Review should be given less authority thanthey have assumed.

often justified on ground that markets in some circumstances produce "too little" infor-mation about securities). But see M. FRIEDMAN & R. FRIEDMAN, supra note 118, at222-26 (arguing that uninhibited market competition usually "protects governmentmechanisms that have been increasingly superimposed on the market"); Easterbrook &Fischel supra, at 692-96 (poorly supported rationales for mandatory disclosure includethe need to protect the unsophisticated investor and the need to increase the supply oftruthful information).

120 See, e.g., O'Connor, Repatriation Appeals Made Easier, 59 LAW INST. J. 58(1985) (Repatriation Legislation Amendment simplifies review procedures and stream-lines handling of veterans' pension claims, thereby alleviating claim backlog and expe-diting appeals).

' Silver v. New York Stock Exchange, 373 U.S. 341 (1963); Trade PracticesAct, 1974, AUSTL. AcTs P. No. 51.

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